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08 - Absorption Costing Example for Posting.docx

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Jocelyn King

Here is an example of how Absorption costing can allow management an opportunity to engage in earnings management. Absorption Costing Example Expense Deferral, Inc. estimates that it will need to produce 1,000,000 units for the fiscal year ending December 31, 2011 if it is to fulfill budgeted sales and end the year with its targeted ending inventory of 100,000 units. Variable costs of production are $10 per unit. Fixed factory expenses are $2,500,000. Opening inventory is $937,500 (75,000 units). Units sell for $15 each. General and administrative expenses are $500,000 per year. Assume an income tax rate of 40%. The company needs to achieve a net income of $1,800,000 in order to meet analysts’ forecasted earnings. What will year 2011 net income be if the estimates above are accurate? Cost per unit = $10 variable + $2.5M/1M fixed = $12.50 Budgeted sales = 75,000+1,000,000-100,000 = 975,000 units Sales (975,000*$15) $14,625,000 Cost of sales Opening inventory $ 937,500 Cost of goods manufactured (1M*$12.50) 12,500,000 Less: closing inventory (100,000*$12.50) (1,250,000) 12,187,500 $ 2,437,500 General and administrative expenses 500,000 Income before tax $1,937,500 Income tax expense (7
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